Creative Destruction

Can you create while destroying?  This apparent oxymoron is a key to understanding capitalism as an engine of human progress.

Josef Schumpeter coined the term “creative destruction” as shorthand for describing the way that free markets, including of capital, result in technological progress.

In Capitalism, Socialism, and Democracy (1942), Schumpeter wrote:

The opening up of new markets, foreign or domestic, and the organizational development from the craft shop to such concerns as U.S. Steel illustrate the same process of industrial mutation—if I may use that biological term—that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. (p. 83)”

In other words, when a useful innovation is discovered and implemented, firms that are on the old technology would see their businesses shrink as consumers find the new products both less expensive and more useful. This process is brought about when there is freedom to risk one’s capital in research that could offer above-normal returns.

W. Michael Cox and Richard Alm, writing for the Concise Encyclopedia of Economics, had this to say regarding Schumpeter’s ideas:

Schumpeter and the economists who adopt his succinct summary of the free market’s ceaseless churning echo capitalism’s critics in acknowledging that lost jobs, ruined companies, and vanishing industries are inherent parts of the growth system. The saving grace comes from recognizing the good that comes from the turmoil. Over time, societies that allow creative destruction to operate grow more productive and richer; their citizens see the benefits of new and better products, shorter work weeks, better jobs, and higher living standards.”

Cox and Alm add that the process of creative destruction results from the working of entrepreneurship and competition. These two features of an economy are those that form essential parts of the explanation of the market mechanism, known also as Adam Smith’s Invisible Hand.

These authors conclude that while capitalism is on balance a blessing, it comes with the undesired effect of some people losing their jobs, even permanently. In short, the concept of creative destruction is similar to the adage in the gym when people try to build muscle: “No pain, no gain.”

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